No signs of catastrophe in housing market

Scott Grannis at Calafia Beach Pundit notes that the Case Shiller Home Price Index continues to show strength or at least stability in housing prices:

The Case Shiller Home Price Index for 20 major metropolitan markets hit bottom in the second quarter of last year and has been rising gradually ever since. Given the lags used in constructing the index, this means that prices likely hit bottom around March of last year. Even after adjusting for inflation, as this chart shows, home prices are up at a 3% annualized rate over the past 8 months.


Housing bears see signs of calamity in boring Case Shiller report

Yesterday’s release of the latest S&P/Case-Shiller Home Price Index showed that house prices are holding up reasonably well:

Data through October 2009, released today by Standard & Poor’s for its S&P/Case-Shiller Home Price Indices, the leading measure of U.S. home prices, show that the annual rate of decline of the 10-City and 20-City Composites improved compared to last month’s reading. This marks approximately nine months of improved readings in these statistics, beginning in early 2009.

On a non-adjusted basis housing prices were flat. On a seasonally adjusted basis, which is probably the better measure, home prices increased by 0.4%. Some large post-bubble cities continued to show month-over-month home price increases, even on a non-adjusted basis:

San Francisco has reported seven consecutive months of positive returns, San Diego has reported six and Los Angeles and Phoenix are close behind with five.

In short, the latest Case-Shiller report shows that after a big run-up over the last five months, housing prices are now essentially flat. They are rising a bit in some markets and falling a bit in others, but this report was mostly a yawner, showing neither a big decline nor a big increase in prices nationally.

But that didn’t stop various commentators from trying to put a strong negative spin on the numbers. At Seeking Alpha, Cliff Wachtel saw evidence of a brewing calamity:  “Latest Case-Shiller Housing Report and its Ramifications: Seeds of a 2010 Crisis?”

Wachtel’s Seeking Alpha colleague Markos Kaminis had misgivings too: “S&P Case Shiller’s Home Price Index Concerns Me.”

At the Seattle Post-Intelligencer, Gerry Spratt wrote, “Report: Housing prices up, but for how long?” I wonder if Ms. Spratt was equally skeptical of housing price increases when prices were soaring a few years ago.

The Wall Street Journal’s Real Time Economics ran this re-assuring headline in response to the Case-Shiller report: “Economists React: ‘Prices Have Further to Fall.'”

At Public Radio’s Marketplace, the headline-writer managed to write this headline: “Signs of instability in housing prices.” Um, prices rose 0.0 percent. Instability?!?

When I wrote a post last month arguing that housing prices had bottomed, the response I received from our readers was uniformly negative. Clearly a large swathe of the public (including the Inflation Watch readership) does not think the recovery in housing prices is for real. Since markets often surprise the majority of people, the prevalence of bearish sentiment makes me more bullish about the housing recovery.

The last time I saw sentiment on housing prices running so strongly in one direction was 2004-05, when almost everyone seemed convinced that prices in bubble markets would continue to rise at 10-15 percent per year in perpetuity.

S&P/Case-Shiller index rises for fifth consecutive month

WSJ: “The S&P/Case-Shiller 20-city home-price index, a closely watched gauge of U.S. home prices, rose 0.3% in September from August in the fifth straight monthly increase….”

Mismeasuring inflation

When home prices plunged  from 2007 to early 2009, some bloggers noted that the Consumer Price Index had done a lousy job of incorporating the decline. The problem, these bloggers pointed out, was the Bureau of Labor Statistics’ use of “owners’ equivalent rent”–the estimated costs that homeowners would assume if they rented their homes instead of owning them–to represent home prices.

Tim Iacono wrote back in 2007: “OER is one of the poorest proxies the world has ever seen as demonstrated by the comparison below with the Case Shiller Home Price Index.”

Source: Tim Iacono

Andrew Jeffrey made a similar point earlier this year:

The statistical alchemists, err, experts, at the Bureau of Labor Statistics use something called “owners equivalent rent,” OER, to measure consumer housing expenses. OER tries to approximate the cost to rent the country’s typical home, and according to the Wall Street Journal makes up 24% of the CPI and 31% of the core CPI, which backs out food and energy costs.

And since even as property values have slid in record-breaking fashion rents remained buoyant, OER has vastly understated the drop in home prices. This means the CPI–were it to reflect some sort of economic reality–would have fallen more than it actually has.

Of course, times change.  Although home prices are still well below their peak, and some observers continue to talk of an ongoing crash in home prices,  the housing market has been on the mend since the spring of 2009–at least if you believe the S&P/Case-Shiller Home Price Index. As was the case in 2007-08, there is a discrepancy between the Case-Shiller index and the owners’ equivalent rent component of CPI, but this time the mismatch causes inflation to be under-reported rather than over-reported.

Let’s look at the numbers. Between April 2009 and August 2009 (the latest month available for the Case-Shiller index), the Case-Shiller index rose from 139.2 to 146.0–an increase of 4.9 percent. By comparison, the owners’ equivalent rent component of the CPI rose from 256.6 to 257.2 during the same period–an increase of just 0.2 percent.  In other words, the rate of home price inflation was nearly 25 times higher than that shown by the CPI.

The CPI as a whole increased from 213.2 to 215.8 — a rise of just 0.1 percent. But if we replace owners’ equivalent rent with the Case Shiller index, CPI would have increased 2.4 percent during this four-month period–an annualized rate of 7 percent.

For simplicity, these calculations are based on seasonally-unadjusted numbers. The results might be slightly different if they were based on seasonally-adjusted figures, but the basic point would not change, i.e.,  reported inflation since April 2009 would be much higher if not for the CPI’s use of owners’ equivalent rent.

Admittedly, the picture is very different if one looks at year-over-year inflation. The Case-Shiller index declined 11.3 percent between August 2008 and August 2009, whereas owners’ equivalent rent increased 1.7 percent. So CPI significantly overstates year-over-year housing inflation. This  overstatement will  gradually get smaller before disappearing entirely in mid-2010, unless housing prices begin to fall again. (Recent reports indicate that housing prices are continuing to rise.)